STRUCTURAL INEFFICIENCIES TRUMP MONETARY POLICY
The unintended effects of global central bankers (led by the US Federal Reserve) market manipulation of interest rates are coming home to roost in the meltdown of emerging market currencies. By manipulating interest rates lower, high percentages of debt/GDP, structural inefficiencies, incumbent and ever increasing social programs has allowed these emerging market countries to borrow on the “cheap” when in fact they should not have been able to extend their credit lines in the first place. The Austrian School economic principal that “you can’t borrow your way to prosperity” is playing out in real time as several emerging market countries are experiencing imploding capital markets and currency disintermediation (flight out of domestic currency). The countries on our radar list, with primary structural problems and large debt/GDP, which are facing massive currency disruptions, are:
- S. Africa
- Russia possibly
Currency manipulation at unprecedented levels with Zirp bound interest rates in the major OECD countries along with massive asset purchases by their central banks has created both artificially high equity prices and distortions of capital investments. “Cheap” money or credit has been extended to companies, countries and geographic regions that has been leveraged and re-leveraged through shadow banking channels such as reverse repurchase agreements. Borrowing in the low interest rate currency and pledging the borrowed funds in a higher interest rate currency and then leveraging (extending credit further) in that currency has created a plethora of capital to either be (mis)invested or extending social programs that are fiscally unsustainable.
Last night, Turkey dramatically raised the central bank reserve rates by 4.25% (from 7.75% to 12%) in a desperate attempt to shore up their plummeting Turkish Lira currency. Initially the global markets responded cheerfully, or better said with relief that another currency contagion such as the 1997 “Asian Flu” might be allayed. Initially, the Turkish lira rallied sharply and global equity markets rallied strongly. Shortly afterwards, in a matter of an hour or so, reality sunk in and the central banks desperation became bloodletting in a pool of sharks. Previous to this desperation move by the Turkish central bank, the central bankers had nearly depleted their currency reserves attempting to stem the tide of capital flight or disintermediation of their domestic currency. Raising rates and desperately buying currency without addressing structural inefficiencies (unsustainable and expensive government social welfare programs, expansive government, overregulation and progressive taxation, expanding budget deficits, etc.) without a degree of urgency is a lame plea for life when starring down the barrel of an assault rifle.
Does this sound familiar? Can this be a prelude to the central bankers of the OECD? Will the USD and the US Federal Reserve soon be engulfed in this fiat currency dilemma? Rest assured, normalization of monetary policy absent of complimentary, and aggressive, economic structural improvements will ultimately be a hollow feign of strength on top of a crumbling foundation.